Underbanked and Underserved

The terms “unbanked” and “underbanked” are falling out of favor. Traditionally, they’ve referred to people who use alternative financial services, such as check cashers or payday loans, because they either lack a bank account or fail to use the accounts they have. The general assumption about both groups is that they lack the income or financial savvy to access these services at a bank.

However this stereotype doesn’t always hold true. Research from Think Finance on underbanked Millennials has found that those with mid-to-high income levels use alternative finance as much as their lower-income peers and sometimes more so.

Consider this:

51% of survey respondents making less than $25,000 annually reported using prepaid debit cards in the last year, which is the same percentage of those who earned $50,000 – $74,999 annually.

29% of those making $50,000 – $74,999 annually reported using check-cashing services – comparable to the 34% of those making less than $25,000.

Usage of payday loans, cash advances, and other emergency cash products was actually greater among Millennials making $50,000-$74,999 (22%) than those making less than $25,000 (15%).

These findings suggest two things. Firstly, alternative financial products aren’t just the last resort of low-income customers who can’t afford traditional banking services. Secondly, being “banked” doesn’t necessarily equate to being well-served.

Traditional banking products are often failing to compete with their non-bank alternatives, even among banks’ own customers. That’s why many in the financial inclusion community are movingaway from the terminology. The term implies that the proper solution for these customers is a deeper relationship with a bank, which may not always be the case.

The uncomfortable truth for banks is that their non-bank competition is often providing services that are more appropriate – and accessible – to the underserved market. For years, U.S. banks have been closing branches, mainly in poor and rural areas, with retail banks falling to their lowest numbers since 1934. Even when banks are accessible to low-income customers, their products are often priced out of reach. Average monthly maintenance fees for checking accounts have soared to a record level of $12.69. Free checking account options have dwindled, while fees for out-of-network ATM usage and overdrafts have reached record highs of $4.35 and $32.74 respectively. Meanwhile, banks have retreated from small-dollar credit, and they’re offering lower interest rates on savings accounts, while increasing their minimum balance and usage requirements. Needless to say, it should come as no surprise that a growing number of customers are looking beyond banks for a better deal.

In spite of the reputation that non-bank financial providers have gained for high fees of their own, they do offer some compelling advantages. First, unlike banks, they’re available in the areas where low-income people live and work, and their extended hours of operation accommodate customers’ busy and unpredictable schedules. In contrast to the somewhat stuffy aura of banks, they often provide friendly and personalized service. They tend to offer more flexible terms with fewer barriers to entry than bank products. And though their fees may seem expensive, they’re far easier for customers to understand, and often more affordable, than fees at a traditional bank.

But that’s not to say that non-bank services are a perfect solution. The average underserved household spends around $2,412 a year on fees and interest associated with alternative financial services. That’s around 9.5% of their average income, which is roughly the same percentage that the average American household spends on food. What’s more, payday lenders don’t generally report to the major credit bureaus, so customers’ repayment history doesn’t build their credit.

While it’s true that some alternative services take advantage of the poor, most are simply dealing with the dilemma of serving low-income customers – one that holds true in countries around the world. Their combination of multiple small transactions, greater risk of default, and geographic inaccessibility makes it hard to serve this demographic profitably without charging fees and higher interest rates.

Mobile finance greatly reduces the expense of delivering financial services while dramatically expanding the geographic range in which these services can be accessed. As such, both the non-profit and for-profit sectors are taking advantage of this potential. The Bill and Melinda Gates Foundation recently granted $11 million to help MasterCard launch a financial inclusion lab in East Africa, which will work with local entrepreneurs, governments, and other stakeholders to generate and scale up financial services innovations. In countries throughout the developing world, both mobile network operators and banks themselves are offering a growing slate of mobile financial products. Meed, a mobile technology company, provides underserved customers with a digital link to brick-and-mortar banks. It partners with banks to offer a checking account with no minimum balance, an interest-bearing savings account that acts as a secured line of credit, and international and domestic money transfers at no additional cost. Their entire suite of products is accessible through a mobile interface for just $9.95 a month in the United States, and the monthly fee is adjusted based on purchasing power parity in other countries. The company also connects its members to each other, letting them earn a share of the interest generated by other members’ transactions. When members invite others to join Meed, these banks give them 25% of the interest generated by the credit transactions of everyone they’ve introduced plus a weighted share of the interest generated by Meed’s worldwide community. This partnership with banks can boost members’ income and savings, while connecting them to a broader suite of products – they call this SocialBoost.

These efforts, and countless others around the world, hope to demonstrate that financial services providers can profitably serve low-income customers without breaking the bank, so to speak. They’re part of a wave of innovation that could make terms like unbanked, underbanked, and underserved obsolete in the coming years.